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Medibank has called for urgent government action on a mysterious rise in the cost of prosthetic devices, saying the rocketing costs were behind a 14 per cent decline in its half year profit.

The $8 billion private health insurer had warned investors in November that rising claims could hit its profit, but Thursday's result was worse than expected and prompted the share price to fall to its lowest level since May 2019.

Medibank chief executive Craig Drummond said the biggest factor in the soft result was a nearly 6 per cent rise in hospital claims, driven by an "extraordinary" 6.4 per cent rise in the cost of prosthetic devices, despite government measures to reduce the cost of prostheses.

Hospital admissions over the six months ending December 31 were up only 1.1 per cent, meaning the claims increase could not be explained by a rise in hospital use.

“The single biggest reason why our hospital claims went up was prostheses, no question," Mr Drummond told The Australian Financial Review. "Reform has had some positive impact, but we've got to move quickly here."

Health insurers have long complained that the private sector pays far more than the public sector or its international counterparts for the same prosthetic devices, which include core items such as pacemakers and hip and knee replacements, as well as ancillary items such as sponges and glue.

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The list and cost of prostheses is set by the federal Department of Health. To address industry concerns, Health Minister Greg Hunt last year did a deal with manufacturers to reduce the cost of core prosthetic devices. But Mr Drummond said the benefits had been cancelled out by the rocketing cost of ancillary items, which had gone up 20 per cent. He said the inclusion of many of these ancillary items was inappropriate and should be reviewed.

He declined to speculate on the reasons for the rise, but others in the industry have accused prostheses manufacturers of deliberately charging more for ancillary items to make up for the fall in cost of core items.

The manufacturers reject this claim, and have told insurers to take a hit to profit instead of complaining about the cost of devices.

“Medibank’s management seems to routinely fail to understand that timely access to the best and latest medical devices is exactly why their customers put up with years of premium pain. Reducing access will only reduce customers," said Ian Burgess, chief executive of the Medical Technology Association of Australia, the lobby group for prosthesis manufacturers.

“If Medibank can still afford to pay a dividend to its shareholders, it can afford to drop its prices for its customers," he said, adding the cost of core prostheses had fallen again on February 1.

"APRA data released on Tuesday found that industry pre-tax margin is now down at 3.86 per cent. It was at 5.2 per cent a year ago, so it's declined 25 per cent in 12 months. I don't think anyone would argue that a 3.86 per cent margin is particularly egregious," he said.

A spokesman for Mr Hunt said the Department of Health had commissioned a review of the miscellaneous category of the prostheses list. He said the findings would be presented to the committee responsible for compiling the list, after which Mr Hunt would make an assessment. He gave no timeframe for the process.

Over the past six months, Medibank made a net gain of 11,700 policyholders. However, all the gains were in the budget AHM brand. The premium Medibank brand lost around 4,500 customers over the 12 months December 31.

Mr Drummond said this was a much better result than the same period two year ago, when the Medibank brand lost 27,000 policyholder. He said he expected this trend to stabilise over the next six month, and that the Medibank brand should increase its policyholders in the 2021 financial year.

While premium revenue was up 2.3 per cent for the six months ending December 31, claims increased by more than double that, rising 5.9 per cent to $2.843 billion.

Group profit after tax was down 14 per cent to $178 million, while operating profit from health insurance operations was down 20.4 per cent to $224 million. The latter figure was offset by strong investment returns. Profit was also helped by a 9.6 per cent reduction in management expenses.

Medibank will pay an interim dividend of $5.70, in line with last year's interim dividend. However where last year's dividend was at a payout ratio of 67 per cent, this year's payout ratio is 88 per cent, three percentage points above Medibanks' target upper limit of 85 per cent.

The result missed market expectations, and the share price closed down 2 per cent at $2.92, its lowest level since May last year.

Citi analyst Nigel Pittaway said: "This is a soft result with the flagged update on cost and capital optimisation the only significant positives."

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